If you buy a home with less than 20 percent down, you’ll probably have to purchase some form of mortgage insurance. Almost all mortgages with a loan-to-value (LTV) exceeding 80 percent require it. Government-backed loans like FHA, VA and USDA mortgages have their own insurance programs. Conventional (non-government) loans exceeding 80 percent LTV usually require private mortgage insurance, or PMI.
There are four ways to buy PMI:
- Monthly PMI, in which the borrower pays an annual premium divided into 12 monthly payments
- Single premium PMI, in which the borrower (or other party like the home seller) pays an upfront premium and there are no monthly payments
- Split premium PMI, which is a combination of upfront and monthly payments
- Lender paid PMI, or LPMI, a mortgage insurance policy covered by the mortgage lender
This article focuses on lender-paid mortgage insurance and can help you determine if it’s a lower-cost option for you.
How does LPMI work?
LPMI is an acronym for lender-paid mortgage insurance. But just because the lender is paying, doesn’t mean it’s a free lunch. With LPMI, you, the borrower, are paying the cost in a different and possibly cheaper way. LPMI lenders may choose to assume the extra risk that goes with a mortgage with a low down payment by charging you a higher interest rate. Or they may purchase a single-premium mortgage insurance policy on your behalf and charge you a higher rate to cover the cost.
Either way, your principal and interest payment is higher than it would be without LPMI. But you won’t be paying monthly mortgage insurance premiums, so your total payment may be cheaper. In some cases, much cheaper.
What are the benefits of LPMI?
Why would LPMI be a better option? What advantages might LPMI have over traditional monthly mortgage insurance?
There are two possible benefits:
- The extra mortgage interest LPMI lenders charge is often less than a comparable monthly mortgage insurance premium.
- Your monthly payment may be more affordable because the cost of the PMI is spread out over the entire loan term.
PMI only makes sense if it costs you less than monthly PMI. You need to run the numbers (or have your mortgage professional do it for you) and then decide.
What are the disadvantages of LPMI?
When considering lender-paid mortgage insurance, you need to understand the potential downsides.
- LPMI involves a higher interest rate built into the loan. That rate never drops, even after your loan balance falls to less than 80 percent of the purchase price.
- Because you pay the higher interest rate for the life of the loan, your total costs may be higher with LPMI than with monthly borrower-paid PMI. It depends on how long you expect to hold the mortgage.
- If you deduct mortgage interest when you do your taxes, LPMI isn’t broken out and thus can’t be itemized on your return. Note that deductibility of PMI has changed once again after being eliminated in 2017. (However, since your interest rate is higher because of the LPMI, you would get a larger deduction if you itemize.)
You may be able to refinance to a loan with a lower interest rate when your equity increases to 20 percent, but consider that mortgage rates, as of this writing, are on the low side, and refinance rates may be higher in the coming years. Refinancing also has sizable out-of-pocket fees and closing costs.
LPMI vs PMI
When weighing the pros and cons of LPMI, first calculate the monthly principal and interest (P&I) of a mortgage with – and without – LPMI. For LPMI, a 0.25 percent rate increase is common when applicants have excellent credit. But your actual rate depends on the lender you choose. Like all mortgage products, it pays to compare several offers when shopping for LPMI home loans.
Here’s how you might look at a PMI vs LPMI loan:
If the 30-year fixed interest rate for a $300,000 mortgage without LPMI is 4.5 percent, its P&I is $1,520. For a 4.75 percent LPMI loan, the P&I would be $1,565 – or $45 more per month.
Next, ask your lender for a monthly mortgage insurance quote. Note that your quote depends mainly on two factors – your credit rating and your down payment.
If you put 10 percent down and have a 720 FICO score, the typical mortgage insurance rate for a 30-year loan is 0.45 percent. So the monthly borrower-paid mortgage insurance would be $113 per month.
If you’re just considering the difference in monthly payment, LPMI clearly offers an advantage in this case, as you’ll pay only $45 more each month for your higher-rate mortgage, but not have to lay out the additional $113 month for mortgage insurance. Your savings going with LPMI would be roughly $88 a month.
Lifetime loan costs
However, the payment difference isn’t the only factor involved.
Once your LTV drops below 80 percent, you can request cancelation of PMI. Your lender will probably grant your request if your loan payment history has been good. Otherwise, your mortgage insurer must by law terminate your policy once your balance drops to 78 percent of the purchase price if paid as scheduled (not prepaid to get to 78 percent).
For a $300,000 loan at 4.5% with a LTV of 90 percent, the loan balance is scheduled to fall below 80 percent on the 74th payment, in just over six years. At that point, you can request cancelation of the monthly policy.
But with LPMI, there is no way to lower the slightly higher interest rate you paid to get LPMI without selling or refinancing.
In addition, PMI insurers recalculate your premium every year as your balance falls. So while the monthly premium for a $300,000 loan starts at $113 per month, it doesn’t stay there. By the 74th month, a $300,000 loan with a 0.45% PMI rate has a monthly premium of $91.
Alternatives to LPMI
There are many ways to buy a home with less than 20 percent down, and the best way for your neighbor might not apply to you.
- Consider a VA home loan if you’re eligible. VA mortgages for service members and eligible family members have no mortgage insurance. However, they do include a funding fee that functions pretty much the same way a single premium mortgage insurance policy does.
- You may be able to avoid PMI and lower your monthly payment with a “piggy-back” mortgage. This means if you put 10 percent down, you take out an 80 percent mortgage and a 10 percent second mortgage. This avoids PMI altogether.
- If you can pay the single premium mortgage insurance yourself, or (better yet) get the home seller to pay it, you may be able to save quite a bit. One national provider charges a single premium of 1.48 percent of the loan balance for borrowers with FICO scores of 720-739. For a $300,000 loan, that’s $4,440. You’ll avoid monthly premiums and recover the upfront cost in less than five years.
Lender-paid mortgage insurance is not a simple concept. So here are a few tips to make your decision easier:
- If you are a first-time buyer, a lower monthly payment may make it easier for you to afford your home and qualify for your mortgage. You are also more likely to sell your home before your mortgage insurance would automatically terminate. So if LPMI gets you a significantly lower payment, that’s likely better for you than paying monthly PMI out of your own pocket.
- If you can afford a single premium policy and you expect to own your home for enough years to surpass the break-even point, that is likely your cheapest option. This would also allow you to qualify for a loan more easily because your payment would be lower.
- If you expect to prepay your mortgage quickly, monthly PMI might be your best bet because you can request cancelation when your LTV hits 80 percent.
- VA home loan guarantees are benefits earned by service members, and VA mortgage rates are often the lowest available. There is no down payment requirement, and you can roll the funding fee into the mortgage. If you are eligible for a VA loan, consider this loan first.
- Other government-backed loans like FHA and USDA tend to have more expensive insurance costs. They require both an upfront premium (which you can finance) and a monthly premium that never terminates regardless of your loan balance. These loans have their advantages, but low insurance cost is not among them.
No one likes paying for mortgage insurance. But no one likes throwing money away on rent, either. So, if you’re determined to buy a home sooner, mortgage insurance can help you do that. And there are many ways to make the cost more affordable.